Did Netflix Forget Rule No. 1 of Consumer Success?

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Netflix (Nasdaq: NFLX  ) made waves last week. The recent split between streaming and DVD plans, with attendant pricing changes that often amount to a 60% increase, resulted in a few more defections than management had expected. Share prices fell through the floor. Netflix stock hasn't been this affordable since last October.

Fellow Fool Rick Munarriz said that "It's time to worry" about even more defections. And I was raring to pen an opposing view in the grand old tradition of Dueling Fools. After all, the surprise expatriates came almost exclusively from the DVD side of the service, which is the division Netflix is trying to forget anyway.

Roses and rainbows; invisible pink unicorns for everybody. Back up the truck before the buy-in window closes!

But something funny happened on the way to that conclusion. This morning, Netflix CEO Reed Hastings sent out an apology in both text and video to angry and/or confused subscribers. Hastings wishes he would have informed us better about the plan changes, though he remains committed to the actual changes. How nice.

But that's not all by a long shot. If it were, I'd shrug my shoulders and move on as if nothing had happened. Then I read on until the real bomb dropped.

The separation of streaming church and DVD state goes way beyond just a pricing strategy. They will soon become two very, very separate services with different site addresses, different queue management systems, and different recommendation histories.

My friends, this is a terrible idea, unless Hastings is trying to just kill the DVD business altogether.

Against the grain
I'm accustomed to giving Hastings the benefit of the doubt when making controversial moves. After all, everyone thought that future DISH Network (Nasdaq: DISH  ) subsidiary Blockbuster and Wal-Mart (NYSE: WMT  ) would kill Netflix with the one-two punch of insane discounts and massive business scale.

If you bought Netflix shares in 2007, when the torches and pitchforks around Los Gatos were at their thickest, you'd be rich now thanks to a 780% return on your investment. Stock Advisor subscribers got a ticket to that ride in the last of five still-open recommendations of the stock.

Even today, Stock Advisor and Fool co-founder David Gardner is on the service's discussion boards, reassuring us all that great companies should be willing to shoot themselves in the foot occasionally -- no risk means no reward. Grab a totally free 30-day trial pass to soak in his entire 860-word essay on the matter.

Who's the king, baby?
So here I sit, fully intending to recommend buying Netflix at these prices, and instead steeling myself for the opposite conclusion.

You see, I'm OK with separating the pricing plans. I'm all right with killing off DVD services in due time. I could even live with the ham-fisted way Hastings has handled the timing of all this change.

But something in this mess tells me that Hastings is losing touch with what made his company great to begin with: convenience.

Ordering a DVD mailer in a couple of clicks with no regard for late fees? Much better than trudging down to the video store and then worrying about the return date. That's customer-friendly genius.

Taking the next step with single-click viewing on your computer, gaming console, or the Internet-connected entertainment gadget of your choice? Well, that's even better.

Asking customers to manage two queues isn't terrible as long as they're in touch with one another. I've added many a title far down on my DVD queue in the hopes of seeing them moved to the streaming menu somewhere down the road. And you know what? It works. Happens more often than you might imagine.

But now the two services will be entirely separate beasts. Giving Gigli an iconoclastic two-star rating on Qwikster won't affect the Netflix ratings for streaming titles and vice versa. Can't find Jerry Maguire in streaming format? You'll need to search again on the DVD side of things rather than just clicking a different button.

I thought Netflix had the convenience mantra nailed to its spinal column by now, even going so far as to land big, red Netflix buttons on the remote controls of many consumer electronics products. One click beats two clicks every time. And one-stop shopping is a big part of the appeal.

Now, you might as well go a la carte. Picking the DVD and streaming services from the same provider now comes with no discernible advantages. Might as well grab the streaming component from (Nasdaq: AMZN  ) and your DVDs from CoinStar's (Nasdaq: CSTR  ) Redbox machines.

The convenience moat just dried up and the alligators are taking a nap. I'm no longer convinced that Reed Hastings has what it takes to win in the rapidly transforming online media market. This might be the right move to make in 2013 or so, when DVD technology starts to look as quaintly antique as VHS tapes. Not now.

Better buys
So over the course of one fateful weekend, Netflix has moved from a screaming buy to a meek hold in my book. The stock should still beat the Dow Jones (INDEX: ^DJI) index and other broad-market trackers over the long term, but I think there are better buys available today. My highest-conviction holding right now is camera-chip maker OmniVision Technologies (Nasdaq: OVTI  ) , which has been severely underestimated by nervous short-term traders.

There's an earnings report due in about a month that might change my tune again -- for better or for worse. Here's hoping that Reed proves me wrong and David right.

Fool contributor Anders Bylund owns shares of Netflix and has created a synthetic long position in OmniVision Technologies, but he holds no other position in any company mentioned. The Motley Fool owns shares of Wal-Mart Stores. Motley Fool newsletter services have recommended buying shares of, Netflix, and Wal-Mart Stores. Motley Fool newsletter services have also recommended buying puts in Netflix and creating a diagonal call position in Wal-Mart Stores. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (4) | Recommend This Article (10)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 19, 2011, at 4:32 PM, knowtheway wrote:

    Did Nexflix not notice what drove BlockBuster into the ground. Let's see - arrogance would be at the top of the list. Come on Netflix - be better than that!

  • Report this Comment On September 19, 2011, at 9:06 PM, CrankyTexan wrote:

    Actually, Blockbuster went of business because going to the mailbox is easier than driving to Blockbuster. Redbox is Blockbuster part 2.

  • Report this Comment On September 20, 2011, at 7:15 AM, lucasmonger wrote:

    I'm surprised nobody has written anywhere that this appears to be a sure sign that Netflix is trying to sell off their DVD business. What other reason could there be for adding two pricing plans and creating two queues and severing the link between the two? Netflix has chosen to go all in on streaming.

    So who could be a buyer of quickster? Dish Network, Amazon, walmart, coinstar? Or how about Hulu? (crazier things have happened)

  • Report this Comment On September 20, 2011, at 5:04 PM, CFischer wrote:

    "Netflix stock hasn't been this affordable since last October."

    Wow, if those aren't the words of someone that is in love with a stock/company, than I don't know what is. Netflix became even more "affordable" today. Something tells me it will be even more affordable in the next year.

    Guess those rosy growth projections went out the window right with its lofty PE.

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